Thursday, January 28, 2010

China's Fixed Exchange Rate

China has defended its fixed exchange rate regime here. A fixed exchange rate regime is where a government fixes its currency's value at a particular specified level via market interventions.

China las long been criticised for its exchange rate regime, because it makes Chinese goods more attractive to us Brits and Americans amongst other since the goods are cheaper than perhaps they should be - hence jobs are lost here to China, hence particularly Americans aren't so happy.

On the other hand, goods being cheap means that inflation in the UK and US has been kept low over recent years - if China revalues, expect inflation to jump in the UK and US...

George Soros

I mentioned George Soros in the last lecture, as the "man who broke the Bank of England", selling pounds in 1992 in response to speculation that the pound would be devalued.

Soros is back in the news with his support for breaking the banks up. Bank regulation is more something you covered in econ101a, but Soros is described in this article as the "legendary speculator".

I should perhaps have made it clear in the lecture that such speculation is only likely to be worthwhile if an exchange rate is fixed, such as in a fixed exchange rate system like the Exchange Rate Mechanism (ERM) of the European Monetary Union (EMU) was.

It's only if exchange rates are fixed that they can end up above or below the equilibrium value, or the rate that a freely floating currency would achieve.

In the case of the pound in 1992, the equilibrium value of the pound had dropped below what the pound was fixed at against the Deutschmark - the old German currency. Currency speculators like Soros would have begun to notice this as an excess supply of the currency would have been noted.

Hence Soros sold many pounds (millions and millions), greatly increasing the supply for the currency. In order to maintain the pound's fixed value against the German mark, the UK (via the Bank of England) had to match this supply with demand. In effect it had to buy the pounds that Soros was selling in order to keep the pound at its fixed rate.

Eventually, the Bank could no longer keep matching the increased supply, and had to let the pound devalue. The main implication of this was that the Bank lost huge amounts of money because it bought assets (pounds) at much too high a price. You saw in the lectures that the pound lost at least 15% of its value after the crisis.

Introducing the Econ101b Blog

Welcome to the Econ101b Blog.

The aim of this blog is to better provide links to relevant and interesting online articles for the material we're covering in lectures.

Almost every day there is some new article on the BBC or FT very relevant to what we're studying.

Hence this blog is for those keen to ground what we're learning in economic reality. If that's you, read on.

It's my aim to put new articles up here each day - but of course that may not necessarily happen. I'll do my best...